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True Cost of Coal Power - Muller, Mendelsohn, and Nordhaus

Posted on 7 October 2011 by dana1981

NOTE:Note: This post has been updated with a substantial correction

Skeptical Science previously examined the fact that the market price of coal power is artificially low because we do not directly pay for all of its impacts, particularly on air quality and climate change.  People who feel these effects do pay them indirectly (i.e. through increased health care costs), but since their costs are not reflected in the market price of coal power, economists call them "externalities," and view them as a major failing of the free market.  As Nobel Prize-winning economist Paul Krugman put it,

"consumers are paying much too low a price for coal-generated electricity, because the price they pay does not take account of the very large external costs associated with generation. If consumers did have to pay the full cost, they would use much less electricity from coal — maybe none, but that would depend on the alternatives.

At one level, this is all textbook economics. Externalities like pollution are one of the classic forms of market failure, and Econ 101 says that this failure should be remedied through pollution taxes or tradable emissions permits that get the price right."

In short, if the people paying for coal power aren't aware of its full costs, then they can't take those costs into account when making decisions regarding how much to consume.  A new paper published in American Economic Review (a very prominent economics journal) from well-known (and somewhat conservative) economists Nicholas Muller, Robert Mendelsohn, and William Norhaus (MMN11) seeks to quantify these externalities.  Krugman provides his analysis of the paper in the link above, and our analysis follows.

Gross External Damages (GED)

MMN11 present a framework to include the externalities associated with air pollution into a system of national accounts.  They estimate air pollution damages for each industry in the USA by quantifying the damages caused by air pollution, and multiplying those damages by the emissions per industry, which they call "gross external damages" (GED).  MMN11 propose that "air pollution becomes another cost of doing business," as is the case for some pollutants.

The paper also compares GED to the value added (VA) by a given industry "to determine whether correcting for external costs has a substantial effect on the net economic impact of different industries."  MMN11 describe their modeling methodology to estimate GED:

"This paper uses the Air Pollution Emission Experiments and Policy (APEEP) analysis model, which is an integrated assessment economic model of air pollution for the United States (Muller and Mendelsohn 2007). The APEEP model connects emissions of six major pollutants (sulfur dioxide (SO2), nitrogen oxides (NOx), volatile organic compounds (VOCs), ammonia (NH3), fine particulate matter (PM2.5), and coarse particulate matter (PM10 –PM2.5)) to the physical and economic consequences of these discharges on society. The effects included in the model calculations are adverse consequences for human health, decreased timber and agriculture yields, reduced visibility, accelerated depreciation of materials, and reductions in recreation services. In addition, for the electric power generation sector, we include the damages from carbon dioxide emissions."

MMN11 provides an estimate of GED costs for various sectors in Table 1.  The largest GED/VA ratio comes from agriculture/forestry and utilities.

GED table

MMN11 break down the GED/VA ratio by industry, and show the 17 industries for which the ratio is at least 45%, or GED is greater than $4 billion per year in Table 2.  Petroleum-fired and coal-fired power generation have the second- and fourth-highest GED/VA ratios, respectively.  Note that the GED estimates in Tables 1 and 2 do not include CO2 emissions and their associated impacts on climate change.  We will examine those costs later.

MMN table 2

What Does a High GED/VA Ratio Mean?

In short, the cost of the damage not accounted for in the market price from industries with GED/VA ratios greater than one (including petroleum and coal power generation) exceed the value they add through their products/services.  However, that doesn't mean we would benefit from getting rid of them altogether, because if we internalized the external costs associated with their air pollution, then their GED would decrease.  As MMN11 put it (emphasis added),

"if the external costs were fully internalized, prices would change, so the results do not imply that the US economy would be better off not having these industries at all...On a formal level, it signifies that a one-unit increase in output of that industry has additional social costs that are higher than the incremental revenues. At an intuitive level, it indicates that the regulated levels of emissions from the industry are too high."

MMN11 suggest a possible interpretation of the high GED/VA ratios is that these industries are not efficiently regulated - the damages associated with their pollution exceed the costs of abatement (through some form of emissions pricing).  Another possibility is that 'VA' doesn't fully account for the value added from a given industry.

Breaking Down Coal Damages

MMN11 delve into more detail regarding the GED associated with coal power generation.  They find that SO2 emissions are responsible for 87% of the damages associated with coal power emissions (excluding climate change), and 94% of the damages come in the form of increased mortality.  For those who claim that burning coal is safe and harmless, the numbers tell a very different story, even without including the effects associated with climate change.

The study also compares the figures for coal, petroleum, and natural gas power plants.  They find that coal accounts for 95% of GED in this sector (though it also accounts for the largest percentage of total power generation), and coal power has the highest GED per kilowatt-hour (kWh) of electricity generated (though as noted in Table 2, petroleum has a higher GED/VA ratio).  The GED per kWh for natural gas is 20 to 30 times lower than for oil and coal, respectively, because its (non-carbon) emissions are so much lower (Table 5).

Climate Change Costs

MMN11 note that CO2 emissions are not yet available for all industries, but are available from electric power generation from the US Energy Information Administration (EIA).  As Skeptical Science has discussed, the costs associated with climate change impacts are calculated through the "social cost of carbon" (SCC), which is a very difficult value to estimate.  Estimates generally range from $19 to $68 per ton of CO2 emitted, but some "skeptic" economists put the value lower.  MMN11 use $27 per ton (from a previous study by Nordhaus, which is a rather conservative estimate) as their central SCC estimate, and also use $6 and $65 per ton as lower and upper bound estimates.

MMN11 incorporate climate change costs into GED for power plants, which they call "GED*" (Table 5).

MMN11 table 5

Using the Nordhaus SCC best estimate ($27 per ton of CO2 emitted) increases the GED for coal power from 2.8 to 3.6 cents per kWh (29%), for example.  This means that CO2 emissions are responsible for approximately one-fourth of total air pollution damages from coal (and petroleum) power generation.  For coal, CO2 emissions cause an additional $15 billion in external damages per year which are not reflected in its market price.  The total GED for coal power ranges from $57 to 90 billion per year, depending on the SCC value (central estimate of $69 billion).  MMN11 note how these values relate to electricity prices:

"In 2002, residential consumers of electricity faced an average market price of 8.4 cents per kwh. Hence, the GED*/kwh associated with electric power generation using coal, oil, and natural gas represents 43, 33, and 7 percent of the average residential retail price of electricity in 2002. Note that residential electricity prices vary by the primary fuel type used in electricity production. In states that primarily rely on coal-fired power, residential electricity prices averaged 6 cents per kwh. The average GED*/kwh of coal-generated electricity is 60 percent of the average residential retail price of electricity in a state relying entirely on coal."


MMN11 note some of the largest sources of uncertainty in their cost estimates:

"we note that the uncertainties are particularly large for four elements: the value of mortality risks, the relationship of this value to age, the mortality effect of fine particulates, and the social cost of CO2 emissions.  Sensitivity analyses using alternative values for these parameters change the magnitude of the results significantly."

Skeptical Science previously examined Epstein et al. (2011), which arrived at a much higher estimate of the external costs of coal combustion, mainly due to a higher estimate of (non-CO2) air pollution damages.  Their median estimate was 18 cents per kWh, as opposed to the median MMN11 estimate of 3.6 cents per kWh - obviously a very large difference. 

Epstein et al. also accounted for several factors not included in the MMN11 analysis, such as public health in Appalachia related to mining, which by itself accounted for approximately 4 cents per kWh in their estimate.  However, the estimates of air pollution externalities varied greatly in the two studies, from 2.8 cents per kWh in MMN11 to approximately 10 cents per kWh in Epstein.  The median climate change impact estimate in Epstein (3 cents per kWh) was also larger than in MMN11 (0.8 cents per kWh) (Figure 1).

coal costs

Figure 1: Average US coal electricity price vs. MMN11 and Epstein 2011 best estimate coal external costs (added to the Skeptical Science graphics page)

So there are clearly significant uncertainties in these estimates.  However, it's important to bear in mind that uncertainties are expected in a Pigovian tax (a tax levied to address a market externality).  Finding the exact emissions price is not necessary, because once the external cost is internalized, the emissions price can be adjusted accordingly.  First we have to take the first step in attempting to internalize the GED.

Take-Home Messages

There are some very important points to take home from these economic studies.  The first is that while these assessments involve significant uncertainties, they agree that the true cost of coal is not accurately reflected in its market price.  In fact, the true cost lies somewhere between ~50% and 300% more than Americans are currently paying.  The two largest contributors to this discrepancy are SO2 emissions (impacting air quality and public health) and CO2 emissions (impacting climate change).  Therefore, regulating SO2 emissions more strictly, and putting a price on CO2 emissions, would benefit the US economy.  As Paul Krugman put it, it's "Econ 101."

There is one final, very big message to get from this economic research.  Most, if not all of the candidates running for the 2012 Republican presidential nomination  (and in fact most Republican politicians in general) have been arguing that Environmental Protection Agency (EPA) regulations are too stringent and harming the economy.  Texas governor and current Republican presidential frontrunner Rick Perry has been the most vocal in these attacks on the EPA, but even relatively moderate Republicans like Senator Susan Collins of Maine have joined in the attacks on "EPA over-regulation."

These studies show that this is exactly the wrong approach.  Air pollution emissions (especially SO2 and CO2) are under-regulated, and increased environmental regulation of these pollutants would benefit the US economy (not to mention public health, both nationally and internationally).  Unfortunately, as we've seen time and time again in recent years, scientific and economic research has little influence over today's Republican politicians.

NOTE: the findings of MMN11 have been added to the rebuttal to the myths Renewable Energy is Too Expensive and CO2 limits will harm the economy

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Comments 1 to 13:

  1. What continues to amaze me is that this huge problem has such a simple solution!

    Use the free market to reduce the use of greenhouse gases. It really, truly isn't that hard.
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  2. Yes, unfortunately many people don't understand that accounting for externalities allows the free market to work properly. All they see is "carbon tax," and in the USA, "tax" is a four letter word.

    But nothing is free, and we have to pay for those emissions one way or another. Either it's efficiently with the free market, or inefficiently as external costs.
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  3. It's a right-wing doctrine that markets are absolutely necessary to set a fair price for something. From a bottom-up analysis, you estimate the fair price of pollution to be 50-300% higher than the current cost of power, and that may be true - but it's also a very broad range! And the cost would have to be estimated and imposed politically.

    Right wingers hate that, and they hate to admit that there are prices that can't be easily estimated with markets, so they prefer to believe the price is 0! Or more precisely: polluters assert the price should be 0, and right-wingers are deeply uncomfortable contesting it, since it would mean abandoning a core right wing belief, trust in markets over political control.
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  4. Actually, free market mechanisms should work once we include the environment polution and climate change into it, i.e. emmission trading scheme. Once the incentives for SO2,CO2-less energy sources (photovoltaic, windmills, geothermal, tidals) kick in, they will be more competitive with coal and the more they are developed, the more their prices drop, until tipping point is reached when coal becomes more expensive and dies.

    The main trouble is: it's hard to put a correct price on environment and enforce it. Wide discrepancy in numbers above (50-300%) means we really don't know how to do it. Or we don't understand the consequences to put the right price.

    The next trouble is: biggest CO2 pollutters (like US) are usually not the nations who pay the consequences of climate change. AGW has the worst consequences for the poorest nations in Africa or Pacific Islanders. So trying to set the price off CO2 pollution within the context of a single economy is not correct. That must be set within the context of global economy.
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  5. I think some economists (may be many) are ahead of politicians in including externalities. I hope eventually some of these economics memes will move from academia into governments. It may be as simple as waiting for the old school to retire, but that might not be soon enough.
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  6. Do people think emissions should be regulated and taxed at source or by the end user? And should the emissions be regulated at national or company level? Think about the following problem:

    If a Japanese company owns a factory in China producing goods to sell to customers in the US, using Australian coal and Iranian oil, produced by corporations based in Europe and Singapore, owned by shareholders from around the world, then whoso emission are they?
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  7. Hyperactive, I don't see the difficulty. Pick any point on the line. Let's say we decide to 'tax' coal at the point of sale to power plants. In your example above that'd drive up costs for the people generating the power, who'd therefor charge the Chinese factory extra for their electricity, the factory would then charge their US customers more for the end goods. Ergo, the added cost is inherently passed down to those getting the final benefit of the fuel use.
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  8. This analysis ignores mercury emitted from coal-fired power plants, and its associated external costs due to numerous health effects. Some good reviews on the topic were published in Ambio, 2007, vol 36, no 1. See especially papers by Mergler et al., "Methylmercury Exposure and Health Effects in Humans: A Worldwide Concern" (p. 3-11) and Swain et al. "Socioeconomic Consequences of Mercury Use and Pollution" (p 45-61). Good starting point if you're unfamiliar with the topic. The U.S. supreme court has mandated that the EPA regulate emissions from coal-fired power plants, so like CO2, those costs will be priced into electricity sooner or later.
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  9. CBDunker: Excellent points. Some have argued that the best place to tax carbon is the point of extraction. We know where oil, coal, and natural gas is being extracted; tax it there based on amount extracted, and let the costs flow downstream into the economy.
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  10. Mercury - Epstein may have included mercury impacts in their Apalachian health estimate. I don't recall offhand though.

    The first step needs to be some sort of emissions pricing system. Once the system is in place, the price can be adjusted as necessary. The problem is the political resistance to putting the system in place to begin with.
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  11. This is not, of course, entirely about the greenhouse effect, but it adds some justification to government efforts to reduce dependence on fossil fuels in general and especially coal. Nothing new about estimating the externalities of coal combustion - I recall one Professor B. Cohen writing about the subject in Scientific American around 1975 . In those days, there was little public interest in the greenhouse effect. If I recall, Cohen's articles mentioned figures of 25 deaths per year per power station, not to mention thousands of cases of lung disease. (I let others verify the accuracy of these quotes)Needless to say, identifying the victims is not so simple. There is no doubt that scientists have a harder job than statistical economists.
    As well as acid rain, do not overlook the effects of toxic metals, including mercury, arsenic and barium. Oh, and one more nasty - uranium. Thousands of tonnes of uranium and a little radium have been emitted into the environment over the years from coal power stations. Considering the public and political hysteria (e.g. in Germany) in relation to the Fukushima nuclear power station disaster, it is remarkable that even the informed public has been so tolerant (and skeptical) for so long over these radioactive emissions from coal thermal plants.
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  12. First step to take is an extraction tax at the source. Second step emission pricing as a kind of regulating mechanism in that area. SO2 and such do have effects in the close proximity of the emitter and not that much worldwide. A lot of fossil carbon ends up in products being burned after their lifetime but are really not taxed in the country of first use. Take second hand cars and other goodies being exported for re-use and such.
    Taxing of biomass, when the biomass is grown sustainable will work out as non-taxable. Monitoring sustainability/biodiversity can be paid out of the emission pricing for those plants so conversion techniques have an advantage to be carbon-negative e.g. producing bio char and materials do be used as fertilizers not to be exported out of the region of production.
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  13. There's a book review in the New York Review of Books by William Nordhaus (one of the authors of the MMN11 paper) that has further discussion on fossil fuel externalities and Pigovian taxes.
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